NEW YORK, Oct 20: Allegations of abuse over how a stock trade is executed may soon bring a new black eye to Wall Street or amount to little more than another warning about high-frequency trading.

The numerous order types - the instructions that govern price and other variables in a trade - and their use by high-frequency traders have sparked a growing debate over the structure of the US marketplace.

Order types can reach an estimated 2,000 variations as a fully electronic market and more than 50 trading venues have multiplied the possibilities of how, when and with whom to trade. And they have changed how buying or selling interest in the market is detected.

Using order types to outsmart other traders has become the latest skirmish in a battle over the merits of high-frequency trading. While the proliferation of new order types baffles many market participants and has sparked talk of abuse, little proof of manipulation has shown up so far.

The largest and most powerful traders in the market use order types to gain a more favorable position in the order book and the exchanges have helped their best clients achieve that edge, said Sal Arnuk, a co-founder of brokerage Themis Trading LLC in Chatham, New Jersey.

“My point is the exchanges are providing their largest customers by revenue and volume, guaranteed economics. If that’s not a red flag, I don’t know what is,” he said. For their part, officials at US exchanges are adamant that new order types are transparent and fully disclosed. Anyone can use order types. They are not just available to high-frequency traders.

Gary Katz, president of the International Securities Exchange, a leading US options exchange, said complaints about poor disclosure are unwarranted as exchanges are required to make documentation on new order types available to everyone.

“This is a fully transparent mechanism,” Katz said at a convention of the Security Traders Association in Washington last month.

Exchange officials deny they serve special interests, noting the Securities and Exchange Commission approves all new order types. The exchanges answer critics by saying some traders have figured out how order types can work to their advantage while other traders have failed to do their homework.

A source at the SEC said the most sophisticated exchange users go to great pains to figure order types out. Even if some may benefit certain participants more than others, “I don’t know that there’s necessarily fire there,” the source said.

But critics say the confusion from order types allows only a few investors to profit from the changes.

“The pace at which order types are changing and morphing is faster than ever,” said Chris Nagy, president of KOR Trading LLC, a consultant to exchanges and brokerages, pointing to a steady stream of regulatory filings for new order types whose complexity, he said, confounds even professional traders.

“Most industry experts can’t keep up,” said Nagy, a former managing director of order strategy at TD Ameritrade Holding Corp, whose job entailed tracking order types.

Themis Trading’s Arnuk finds especially troubling so-called “hidden” order types that are non-routable, which means orders can be kept from going to another exchange to be executed at less favorable terms. Arnuk said such orders are abusive as the user can wait for a trading opportunity that better suits their needs. Both Nagy and Arnuk called for a moratorium on order types, and Themis has urged the SEC to annul most order types and set up a panel to scrutinise any new proposals.

Exchange operator BATS Global Markets said in February that the SEC had sought information about the development, modification and use of order types, and its communications with certain market participants, including members that are affiliated with its stockholders and directors.

A moratorium would limit competition and would not be in the best interest of the US market, said Chris Isaacson, chief operating officer at BATS, speaking at the securities traders convention.—Reuters

Updated Oct 21, 2012 01:51am

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